Confidence Dims For The Star

Brokers have taken the knife to Star Entertainment forecasts but most see valuation support.

-Market share lost in slots because of the construction of the new Sovereign Room
-Cost reductions expected to insulate earnings in difficult revenue environment
-Global operator interest may pose a catalyst

By Eva Brocklehurst

A weak trading update from The Star Entertainment ((SGR)) sent brokers scurrying to review earnings estimates and the outlook for the domestic gambling sector. The company has guided to operating earnings of $550-560m versus $568m in FY18. Second half VIP revenue is forecast to be down -30%, as weak economic conditions have affected player confidence.

UBS points out, unlike the first half, Star Entertainment is no longer taking meaningful market share. The broker lowers main floor and VIP assumptions to reflect growth in line with the broader gambling market and this results in downgrades to estimates of -16-21% in FY19-21.

Credit Suisse points out the company has lost market share in slot machines in Sydney because of the construction of the new Sovereign Room, which has forced the moving of banks of machines. Weaker premium mass play has also affected this segment.

Guidance compares to prior forecasts for operating earnings of $587m and Morgans downgrades to Hold from Add because of the uncertainty. Early broad-based improvement in the second half, reported at the first half result, has eased back and the broker notes domestic revenue from January 1 to June 8 was up just 0.3%. Slots revenue was up 1.6%, as Queensland experienced increased market share. Table game revenue, meanwhile, was down -0.8%.

Domestic conditions such as low wages growth, falling house prices and higher petrol prices as well as lower VIP turnover have all affected the second half, Ord Minnett suggests. Construction in Sydney and lower hold rates may be partially to blame, yet the broker deduces that the broader slowdown in discretionary expenditure is affecting the whole domestic casino market.

Macquarie was surprised by the intensity of the downturn in domestic business but envisages a strong focus on cost containment will provide greater leverage to a recovery and cushion the downside risk.

Cost Reductions

A cost reduction program of $40-50m per annum from the December quarter has been flagged and UBS believes this is prudent in the current environment. Cost savings will help achieve FY20 forecasts, Morgan Stanley agrees, but suspects it will be challenging if economic headwinds persist and the VIP market remains dormant.

Credit Suisse incorporates just half of the forecast savings into its numbers, believing execution may not be easy. The program aims to eliminate 15-20% of the company's salaried, overhead positions. The broker also assesses net debt will peak at 2.6x operating earnings in FY23, when Crown Sydney ((CWN)) will affect earnings the most, and the investment in Queen's Wharf in Brisbane will be fully expended.

Multiplex has been selected as the preferred contractor for the shell, core and façade work on Queen's Wharf, subject to Queensland government approval. Terms and costs are in line with budget, which Morgans suspects will allay some investor concerns. Importantly, around 60% of all project works will have either been completed or locked away at a fixed cost post the Multiplex contract.

The cost reductions are expected to be achieved by the end of the first quarter in FY20 and Morgans expects the boost to earnings will help insulate earnings in a difficult revenue environment. The company will employ a centralised approach for a number of support functions going forward.

Deutsche Bank is sceptical that the company can execute on its cost reductions and expects threat of a second Gold Coast casino licence to weigh on the share price. While anticipating a slowing in domestic revenue growth in the second half, the broker acknowledges the extent could be larger than previously expected. Still, Deutsche Bank finds the valuation attractive and retains a Buy rating.

Takeover Interest?

Ord Minnett notes there has been increased interest in Australian assets recently and calculates valuation support for Star Entertainment at $3.80, versus a sum-of-the-parts valuation of $4.80. Thus, the broker maintains a Buy rating and assesses valuation infers the Sydney casino could almost entirely support the share price. The slump in the shares after the downgrade is considered overdone, as rival Crown Resorts is likely to be facing similar domestic headwinds in Victoria.

Ord Minnett suggests global operators running the ruler over Australian gambling assets may pose a catalyst for the near term, although agrees macro economic headwinds and concerns over consumer confidence and tourism exist.

UBS believes comparisons with Crown Resorts and Sky City ((SKC)) multiples are becoming less relevant while the Gold Coast casino licence process is underway. The broker bases forecasts and valuation on no change to the competitive environment, and a tax outcome in Sydney which assumes no reduction in main floor tax revenue. As a result, share price upside is assumed if these outcomes are realised, although this is likely to occur in 2020.

FNArena's database has six Buy ratings and one Hold (Morgans) for The Star Entertainment with a consensus target of $4.86, signalling 24.5% upside to the last share price. The dividend yield on FY19 and FY20 forecasts is 5.5% and 5.3% respectively.

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